Price/Earnings Ratio (PE ratio)

What does a high PE ratio really mean? What is the significance of a high PE ratio and does it necessarily means a good chance to short a certain stock and make money?

The PE ratio we commonly use is trailing P/E:

It is obtained by taking the current price divided by the previous annual earnings. For the S&P 500, we take the price divided by the trailing earnings per share. In short, Market Price ÷ Earnings Per Share It gives us an idea of how much (in terms of multiples) are you paying for each dollar of earnings. For example, a PE ratio of 15 simply means you are willing to pay 15 dollars now for each dollar of previous earnings.

With Warren Buffet saying that “Buy when people are fearful, sell when people are greedy”. A PE ratio of 15 should be our golden